Measurement of Operational Risk - Bank Management - Lecture Slides, Slides of Banking and Finance

Download Measurement of Operational Risk - Bank Management - Lecture Slides and more Slides Banking and Finance in PDF only on Docsity! Measurement of Operational Risk Docsity.com Approaches to Measure Operational Risk • Spectrum of approaches – Basic indicator - based on a single indicator – Standardized approach - divides banks’ activities into a number of standardized industry business lines – Advanced measurement approach – Loss distribution approach • Basic Indicator – 30% of gross income Docsity.com Basel I • Calculate risk weighted assets for on-balance sheet items. • Assets are classified into categories. • Risk-capital weights are given for each category of assets. • Asset value is multiplied by weights. • Off-balance sheet items are expressed as credit equivalents. Docsity.com Minimum Capital Requirement Pillar One Credit Risk Risk Market Risk Standardized Internal Ratings Credit Risk Models Credit Mitigation Other Risk Trading Book Banking Book Operational Others Docsity.com Regulatory Approach Risk Based/ less Regulatory Capital: Basic Indicator Standardized Internal Measurement Approach Loss Distribution Rate Risk Risk Expected Bank Bank Base jan Bank Type 1 Type K Loss Business Br Business Rate ary Savers Linet |r linet |i, beeen’ 2 Unexpected Business| B Business Rate Rate 2 loss Line 2 [PS Line 2 2 Expected 2 a Catastropic = ieee z é Unexpected Business Business x Loss ine Line 3 Loss» Loss Business Pe Business| ate nate Linen Linen | sr N Lossy. Loss os Rate of progression between stages based on necessity and capability Docsity.com Operational Risk - Basic Indicator Approach • Capital requirement = α% of gross income • Gross income = Net interest income + Net non-interest income Note:  supplied by BIS (currently  = 30%) Docsity.com Example • Bank’s Gross Income = Rs.395,479,059 • Capital charge for operational risk • 30% of Gross Income = Rs.118,643,717 or • 15% of Gross Income = Rs.59,321,858 Docsity.com Basic Indicator Approach Bank ($ Million) BIS (.3) RBI (.15) Capital Deficiency / Surplus State Bank of India 38.9 19.4 1.16 -1574.13 Punjab National Bank 11.5 5.72 0.7 -717.14 ICICI Bank Ltd. 11.3 5.62 2.76 -103.62 Bank of Baroda 2.96 1.48 0.81 -82.71 Canara Bank 3.28 1.64 0.91 -80.21 Corporation Bank 1.1 0.55 0.31 -77.41 Oriental Bank of Commerce 1.42 0.71 0.55 -29.09 HDFC Bank Ltd. 1.79 0.89 0.69 -28.98 Bank of India 2.48 1.24 1.08 -14.81 Syndicate Bank 1.55 0.77 1.15 33.04 UTI Bank 0.9 0.45 0.61 26.22 Union Bank 1.87 0.93 1.12 16.96 Docsity.com Advanced Management Approach • Qualitative standards – organizational requirements to create an independent operational risk function • Quantitative standards – collection of operational loss data and the development of operational risk measurement models. – capturing potentially severe tail loss events with a 99.99 percentile confidence interval – Track internal loss data based on a minimum five-year observation period – Use relevant external data – Use scenario analysis (expert opinion along with external data to evaluate its exposure to high-severity events) Docsity.com Qualitative Risk Measure • Critical assessment method – Questionnaire format and interviews with bank managers to identify operational risk events. Docsity.com Key Risk Indicators approach • Identifying indicators to measure the scope of business loss and the risk involved. • Example: portfolio size, volume of transactions traded, volume of deals routed through payment and settlement systems. • Key risk indicators is more a predictive model than a cause-and-event approach. Docsity.com Causes Risk Identification Matrix Effect Direct Effect Indirect Effect Loss from Counter party Loss from External Factors Other Losses Operational Loss Increase Expences Less Income IN PV (Net Present Value) , MV (Market Value) Uncertain Information on Counter Party Uncertain Information on Market Other Causes Failed processes, People, Systems, external events Docsity.com Capital Requirements for Operational Risk Management “ kk ~~ b ™ ~ tg: | Regulation of Loss ‘\ _ | Adjust for Adjustment jo Re reting Risk Distribution data points y Changes df Risk Capital = y = = 4 _ a NX Adjustment \. Adjustment» | Allocation of Initial ~ for N for > eee Capital Capital Buisness Performance ee : risk capital y Complexity measures ™ _ Risk —~\ Net or Risk Bank Specific Adjusted \ Correction Mitigation ” Economic i i Analysis > i Adjustment Capital y: Peiitictions Capital Docsity.com Operational Risk Management Triangle Docsity.com Financial Implication • Loss from operations • Capital requirement • Value additions to the bank Docsity.com Performance Measurement • Control of operational risk • Optimization of investment • Identification of best practices • Benchmarking Docsity.com